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‘Crowdfunding' Law Firm Possible in Limited Circumstances

July 29 — Cash-strapped lawyers in need of funds to launch a new practice “may engage in certain types of crowdfunding,” the New York State bar's ethics committee said in a June 29 opinion.

The opinion appears to be the first one from any bar association's ethics panel to address the propriety of financing a law firm through crowdfunding, a form of alternative finance that has grown popular in the nonprofit and business sectors but made few waves in the legal world.

The panel said lawyers generally have eschewed crowdfunding—defined as “funding a project or venture by raising small amounts of money from a large number of people”—because of long-established ethics rules that forbid sharing legal fees with nonlawyers or giving nonlawyers equity stakes in law firms.

The committee acknowledged those restrictions and said they narrowly limit the circumstances in which crowdfunding is allowable in bankrolling a law practice.

“Any form of fundraising that gives the investor an interest in a law firm or a share of its revenue would be prohibited,” the committee said, citing New York Rules of Professional Conduct 5.4(a) (prohibiting fee-sharing with nonlawyers) and 5.4(d) (attorney cannot practice law in for-profit entity if nonlawyer owns any interest in venture).

“However, in some circumstances a law firm may give the funding source some kind of reward,” the committee added. “For example, a law firm may send a funder non-confidential memoranda discussing legal issues (provided the law firm complies with any applicable advertising rules),” it stated.

Additionally, the committee said a lawyer may agree “to provide pro bono legal services to certain charitable organizations” identified by donors—so long as the lawyer is competent to render those services and those representations do not create conflicts of interest.

Untested Waters

The opinion responds to an inquiry from two recent law school graduates who said they accumulated substantial student loan debt and are looking to crowdfunding as a way to avoid further borrowing as they raise capital for a law firm they plan to start.

According to the opinion, crowdfunding is typically used to raise philanthropic donations and to help cash-strapped entrepreneurs acquire capital to start businesses and test new products. Fundraisers and contributors meet through online platforms operated by third parties that charge fees based on amounts raised.

A recent article in the Oregon bar's journal notes that as of May 2015 no jurisdiction had issued guidance on the propriety of using crowdfunding to finance a law firm.

The authors attributed the paucity of authority to the fact that “ethics law can be slow to catch up with modern practice” where new technologies are concerned.

But they also said a “preliminary look at crowdfunding suggests that it is not per se prohibited,” and that the permissibility of the practice depends on “the type of funding model used” and the “specifics of how the lawyer implements” a campaign. Amber Hollister & Beverly Michaelis, Tread Carefully: Crowdfunding Your Law Practice, 75 Or. State B. Bull. 7 (May 2015).

The New York panel reached the same conclusion.

Problematic Models: Royalty and Equity.

Citing an online clearinghouse on the subject, the New York bar ethics panel said it was aware of five basic approaches to crowdfunding:

▸Donation—used “for philanthropic causes where there is no material or financial return” to contributors.

▸Reward—used to “pre-sell” or “create a large following” for a product or service by providing funders with a sample of the product or service.

▸Lending—operates much like “the traditional working capital loan.”

▸Equity—used to finance new businesses by giving contributors ownership interests in the ventures.

▸Royalty—used to fund product development by giving investors a cut of sales proceeds from a product.

The committee said the lending model would not meet the inquirers' goal, and that the donation model might be unattractive because contributors might be inclined to donate directly to the firm without using a platform that extracts brokerage fees.

“But we see no ethical issues with the donation model, as long as the lawyers make clear that donors will receive nothing in return and that the law firm is designed to be a profit-making enterprise,” the committee said.

On the other hand, the committee determined that the royalty and equity models “would clearly violate” Rules 5.4(a) and 5.4(d).

Reward Model

The committee said the ethical propriety of crowdfunding under a “reward model” would depend on the types of incentives offered to donors.

The inquirers suggested three types of rewards: (1) informational pamphlets; (2) reports on the firm's progress; and (3) the lawyers' promise to perform pro bono work for third-party charitable organizations.

The committee found no ethical problems with offering rewards in the form of informational pamphlets, whitepapers or reports on the firm's progress—so long as the lawyers comply with Rule 7.1 if those materials meet the definition of attorney advertising, and so long as the lawyers “take care that their writings on legal topics do not give individual legal advice.”

Offering rewards in the form of donated pro bono services to third-party nonprofit organizations “raises several issues,” the opinion states.

Citing New York State Ethics Op. 971 (2013), the committee said a lawyer should only accept such an engagement if she “is, or intends to become, competent to handle the matter.” Additionally, it said a lawyer should not accept cases that “would involve an impermissible conflict of interest under Rule 1.7 or Rule 1.9.”

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